By Michael J. Madormo – Sovereign wealth funds (SWFs) are large pools of state controlled wealth that are usually a product of surplus revenue from commodity exports. States use SWF investment for various objectives like macroeconomic stabilization, savings, and development. Although SWFs are not a new phenomenon (the Kuwait Investment Authority was established in 1953), there has been exponential growth in the size, scope, and diversity of SWF investment over the last 10-15 years. SWFs currently hold about $3 trillion and their assets could reach $10 trillion by 2012. The top five SWFs (UAE, Saudi Arabia, China, Russia, and Singapore) account for 70% of investment, but other countries as disparate as Kazakhstan, Australia, and the US (Alaska) operate SWFs as well.[1]
The rise of SWFs has attracted attention from Congress regarding the potential for states to use SWF investment for political or economic-power goals that could harm US national security. Critics argue that SWFs could steal national security and trade secrets, manipulate markets, and engage in insider trading. State-directed investment creates the potential for states to manipulate investment for political goals. SWF in the US now include a range of American financial assets, not only government bonds, thus increasing a country’s capability to steal intellectual property or security-sensitive material. Many of the states with SWFs are autocratic, energy exporting states whose interests do not always align with US national security interests. Most importantly, SWFs lack transparency in their investing, which is antithetical to a free market system and foster speculation about their actions and intentions.
Despite these concerns, there is no present evidence that SWFs directly threaten US national security. SWF investments tend to be passive and long-term with little interest in security-sensitive assets. Moreover, much of the criticism of SWF addresses them as if they were a monolithic, conspiring actor, but there is significant diversity in terms of objectives and practices, and there is no evidence of cohesion for strategic goals. Most importantly, if states want to steal trade secrets or manipulate critical infrastructure, SWF investment is the least effective way of going about it. The size, scope and character of SWFs attract scrutiny, which is disadvantageous for illicit activities. SWFs tend to lack transparency for reasons of national pride, the protection of their large portfolios from front-running investments, and the lack of clear international rules regarding disclosure.[2]
There are multiple levels of review to prevent security-sensitive investments by SWFs. The Committee on Foreign Investment along with eight separate Congressional Committees have oversight responsibility, and the Foreign Investment and National Security Act mandates additional scrutiny when foreign governments seek to acquire US assets. SWFs have demonstrated an openness to adapt to international standards as well. For example, the IMF’s international working group of sovereign wealth funds met in early July to establish investment rules and voluntary guidelines for transparency.
SWF investment has been beneficial for the US economy. SWFs have served as stabilizing economic forces of late, bailing out several major American financial services corporations that have suffered due to high energy costs, trade imbalances, and the sub-prime rate mortgage crisis. For example, the Abu Dhabi Investment Authority infused $7.5 billion into Citigroup when it was nearing financial collapse in November 2007, and Merrill Lynch received a $5 billion investment from Temasek Holdings (Singapore’s SWF).[3]
At a more fundamental level, the adverse reaction to the rise of SWFs is evidence of American discomfort with the dramatic power shifts that are taking place geo-economically. Rapid economic growth in China and high energy prices for oil producers have contributed to the emergence of non-traditional sources of foreign investment. Polling shows that most Americans believe foreign investment has a detrimental effect on the US economy and national security, and reactions were overwhelmingly negative in response to the recent SWF investments.[4] Consequently, it is appealing for politicians to talk tough about regulating SWFs, especially during a period of economic decline in the run up to an election. Senators Dodd and Bayh have emphasized the need for increased scrutiny of SWF investments.
History provides other examples of unfounded fears of foreign takeovers. According to many experts in the late 80s, Japan was waging a covert economic war against the US through predatory trading practices and buy-outs of American businesses. Popular culture depicted the Japanese stereotypes of homogeneity and strength, which seemed like a sharp contrast to America’s individualism and weakness (see Ron Howard’s 1986 film Gung Ho or Philip Kaufman’s 1993 film Rising Sun). Yet subsequent developments demonstrated that these fears were largely unfounded.[5] The future could be one where states are competing for more SWF investment, rather than the reverse. Instead of enacting more stringent regulations that would push SWF investors elsewhere, it would be beneficial for the US to find ways to attract SWF investment. To avoid the mistakes of the 1990s concerning Japanese investment, policy makers and SWFs together must avoid polarized positions and educate each other.
[1] International Monetary Fund, “Sovereign Wealth Fund Working Agenda” February 29, 2008
[2] Edwin Truman, “The Rise of Sovereign Wealth Funds: Impacts on US Foreign Policy and Economic Interests” Testimony before the Committee on Foreign Affairs, US House of Representatives, Washington, May 21, 2008.
[3] Remarks by Tom Karol President of the Sovereign Investment Council to the European Institute, April 10, 2008
[4] Public Strategies Incorporated, US National Omnibus Survey, February 12-13, 2008
[5] Robert Reich, “Is Japan Out to Get Us?” The New York Times February 9, 1992.
Michael J. Madormo is a Program Associate with the Security for a New Century program at the Stimson Center.
The New Foreign Menace? Sovereign Wealth Funds and US National Security
In
By Michael J. Madormo – Sovereign wealth funds (SWFs) are large pools of state controlled wealth that are usually a product of surplus revenue from commodity exports. States use SWF investment for various objectives like macroeconomic stabilization, savings, and development. Although SWFs are not a new phenomenon (the Kuwait Investment Authority was established in 1953), there has been exponential growth in the size, scope, and diversity of SWF investment over the last 10-15 years. SWFs currently hold about $3 trillion and their assets could reach $10 trillion by 2012. The top five SWFs (UAE, Saudi Arabia, China, Russia, and Singapore) account for 70% of investment, but other countries as disparate as Kazakhstan, Australia, and the US (Alaska) operate SWFs as well.[1]
The rise of SWFs has attracted attention from Congress regarding the potential for states to use SWF investment for political or economic-power goals that could harm US national security. Critics argue that SWFs could steal national security and trade secrets, manipulate markets, and engage in insider trading. State-directed investment creates the potential for states to manipulate investment for political goals. SWF in the US now include a range of American financial assets, not only government bonds, thus increasing a country’s capability to steal intellectual property or security-sensitive material. Many of the states with SWFs are autocratic, energy exporting states whose interests do not always align with US national security interests. Most importantly, SWFs lack transparency in their investing, which is antithetical to a free market system and foster speculation about their actions and intentions.
Despite these concerns, there is no present evidence that SWFs directly threaten US national security. SWF investments tend to be passive and long-term with little interest in security-sensitive assets. Moreover, much of the criticism of SWF addresses them as if they were a monolithic, conspiring actor, but there is significant diversity in terms of objectives and practices, and there is no evidence of cohesion for strategic goals. Most importantly, if states want to steal trade secrets or manipulate critical infrastructure, SWF investment is the least effective way of going about it. The size, scope and character of SWFs attract scrutiny, which is disadvantageous for illicit activities. SWFs tend to lack transparency for reasons of national pride, the protection of their large portfolios from front-running investments, and the lack of clear international rules regarding disclosure.[2]
There are multiple levels of review to prevent security-sensitive investments by SWFs. The Committee on Foreign Investment along with eight separate Congressional Committees have oversight responsibility, and the Foreign Investment and National Security Act mandates additional scrutiny when foreign governments seek to acquire US assets. SWFs have demonstrated an openness to adapt to international standards as well. For example, the IMF’s international working group of sovereign wealth funds met in early July to establish investment rules and voluntary guidelines for transparency.
SWF investment has been beneficial for the US economy. SWFs have served as stabilizing economic forces of late, bailing out several major American financial services corporations that have suffered due to high energy costs, trade imbalances, and the sub-prime rate mortgage crisis. For example, the Abu Dhabi Investment Authority infused $7.5 billion into Citigroup when it was nearing financial collapse in November 2007, and Merrill Lynch received a $5 billion investment from Temasek Holdings (Singapore’s SWF).[3]
At a more fundamental level, the adverse reaction to the rise of SWFs is evidence of American discomfort with the dramatic power shifts that are taking place geo-economically. Rapid economic growth in China and high energy prices for oil producers have contributed to the emergence of non-traditional sources of foreign investment. Polling shows that most Americans believe foreign investment has a detrimental effect on the US economy and national security, and reactions were overwhelmingly negative in response to the recent SWF investments.[4] Consequently, it is appealing for politicians to talk tough about regulating SWFs, especially during a period of economic decline in the run up to an election. Senators Dodd and Bayh have emphasized the need for increased scrutiny of SWF investments.
History provides other examples of unfounded fears of foreign takeovers. According to many experts in the late 80s, Japan was waging a covert economic war against the US through predatory trading practices and buy-outs of American businesses. Popular culture depicted the Japanese stereotypes of homogeneity and strength, which seemed like a sharp contrast to America’s individualism and weakness (see Ron Howard’s 1986 film Gung Ho or Philip Kaufman’s 1993 film Rising Sun). Yet subsequent developments demonstrated that these fears were largely unfounded.[5] The future could be one where states are competing for more SWF investment, rather than the reverse. Instead of enacting more stringent regulations that would push SWF investors elsewhere, it would be beneficial for the US to find ways to attract SWF investment. To avoid the mistakes of the 1990s concerning Japanese investment, policy makers and SWFs together must avoid polarized positions and educate each other.
[1] International Monetary Fund, “Sovereign Wealth Fund Working Agenda” February 29, 2008
[2] Edwin Truman, “The Rise of Sovereign Wealth Funds: Impacts on US Foreign Policy and Economic Interests” Testimony before the Committee on Foreign Affairs, US House of Representatives, Washington, May 21, 2008.
[3] Remarks by Tom Karol President of the Sovereign Investment Council to the European Institute, April 10, 2008
[4] Public Strategies Incorporated, US National Omnibus Survey, February 12-13, 2008
[5] Robert Reich, “Is Japan Out to Get Us?” The New York Times February 9, 1992.
Michael J. Madormo is a Program Associate with the Security for a New Century program at the Stimson Center.